10-K 1 a1231201310-k.htm 10-K 12.31.2013 10-K
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
Commission file number 0-13203
LNB Bancorp, Inc.
(Exact name of the registrant as specified in its charter)
Ohio
 
34-1406303
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
457 Broadway, Lorain, Ohio
 
44052-1769
(Address of principal executive offices)
 
(Zip Code)
(440) 244-6000
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Shares,
par value $1.00 per share
Preferred Share Purchase Rights
 
The NASDAQ Stock Market
The NASDAQ Stock Market
Securities Registered Pursuant to Section 12(g) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
None
 
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨        No  þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨        No  þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ        No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ        No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  o
  
Accelerated filer  o
  
Non-accelerated filer  þ
  
Smaller reporting company   o
 
  
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨        No  þ
The aggregate market value of the common shares held by non-affiliates of the registrant at June 30, 2013 was approximately $70,125,702.
The number of common shares of the registrant outstanding on February 26, 2014 was 9,664,972.
Documents Incorporated By Reference
Portions of the Registrant’s definitive Proxy Statement to be filed in connection with its 2014 Annual Meeting of Shareholders are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14) of this report.
Except as otherwise stated, the information contained in this Annual Report on Form 10-K is as of December 31, 2013.
 



TABLE OF CONTENTS
 
 
Page
PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
PART IV
Item 15.



PART I
 
Item 1.
Business
LNB Bancorp, Inc. (the “Corporation”) is a diversified banking services company headquartered in Lorain, Ohio. It is organized as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). Its predecessor, The Lorain Banking Company, was a state chartered bank founded in 1905. It merged with the National Bank of Lorain in 1961, and in 1984 became a wholly-owned subsidiary of LNB Bancorp, Inc.
The Corporation engages in lending and depository services, investment services, and other traditional banking services. These services are generally offered through the Corporation's wholly-owned subsidiary, The Lorain National Bank (the “Bank”).
The primary business of the Bank is providing personal, mortgage and commercial banking products, along with investment management and trust services. The Lorain National Bank operates through 20 retail-banking locations and 28 automated teller machines (“ATM's”) in Lorain, Erie, Cuyahoga and Summit counties in the Ohio communities of Lorain, Elyria, Amherst, Avon, Avon Lake, LaGrange, North Ridgeville, Oberlin, Olmsted Township, Vermilion, Westlake and Hudson, as well as a business development office in Cuyahoga County. The Bank also operates an office in Columbus, Ohio that specializes in originating Small Business Administration (SBA) related loans.
Services
Commercial Lending.    The Bank's commercial lending activities consist of commercial and industrial loans, commercial real estate loans, construction and equipment loans, letters of credit, revolving lines of credit, Small Business Administration loans and government guaranteed loans. The Bank's wholly-owned subsidiary, North Coast Community Development Corporation, offers commercial loans with preferred interest rates on projects that meet the standards for the federal government's New Markets Tax Credit Program.
Residential, Installment and Personal Lending.    The Bank's residential mortgage lending activities consist of loans for the purchase of personal residences, originated for portfolio or to be sold in the secondary markets. The Bank's installment lending activities consist of traditional forms of financing for automobile and personal loans, indirect automobile loans, second mortgages, and home equity lines of credit. The Bank provides indirect lending services to new and used automobile dealerships located in Ohio, Kentucky, Indiana, North Carolina, Tennessee and Georgia. Through this program, the Bank has generated high-quality short-term assets that have been placed in its own portfolio or sold to several investor banks.
Deposit Services.    The Bank's deposit services include traditional transaction and time deposit accounts, as well as cash management services for corporate and municipal customers. The Bank has occasionally supplemented local deposit generation with time deposits generated through a broker relationship. Deposits of the Bank are insured by the Bank Insurance Fund administered by the Federal Deposit Insurance Corporation (the “FDIC”).
Other Services.    Other bank services offered include safe deposit boxes, night depository, U.S. savings bonds, travelers' checks, money orders, cashier's checks, ATM's, debit cards, wire transfer, electronic funds transfers, foreign drafts, foreign currency, electronic banking by phone or through the internet, lockbox and other services tailored for both individuals and businesses.
Competition and Market Information
The Corporation competes primarily with 18 other financial institutions with operations in Lorain County, Ohio, which have Lorain County-based deposits ranging in size from approximately $1.1 million to over $1.0 billion. These competitors, as well as credit unions and financial intermediaries, compete for Lorain County deposits of approximately of $4.1 billion.
 The Bank's market share of total deposits in Lorain County was 22.11% in 2013 and 22.14% in 2012, and the Bank ranked number two in market share in Lorain County in 2013 and 2012.
The Corporation's Morgan Bank division operates from one location in Hudson, Ohio. The Morgan Bank division competes primarily with 10 other financial institutions for $667 million in deposits in the City of Hudson, and holds a market share of 17.39%.
The Bank has a limited presence in Cuyahoga County, competing primarily with 27 other financial institutions. Cuyahoga County deposits as of June 30, 2013 totaled $38.7 billion. The Bank's market share of deposits in Cuyahoga County was 0.07% in 2013 and 2012 based on the FDIC Summary of Deposits for specific market areas dated June 30, 2013.



1


Business Strategy
The Bank seeks to compete with larger financial institutions by providing exceptional local service that emphasizes direct customer access to the Bank's officers and compete with smaller local banks by providing more convenient distribution channels and a wider array of products. The Bank endeavors to provide informed and courteous personal services. The Corporation's management team (“Management”) believes that the Bank is well-positioned to compete successfully in its market area. Competition among financial institutions is based largely upon interest rates offered on deposit accounts, interest rates charged on loans, the relative level of service charges, the quality and scope of the services rendered, the convenience of the banking centers and, in the case of loans to commercial borrowers, relative lending limits. Management believes that the commitment of the Bank to provide quality personal service and its local community involvement give the Bank a competitive advantage over other financial institutions operating in its markets.
Supervision and Regulation
The Corporation is subject to the supervision and examination of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The BHC Act requires prior approval of the Federal Reserve Board before acquiring or holding more than a 5% voting interest in any bank. It also restricts interstate banking activities.
The Bank is subject to extensive regulation, supervision and examination by applicable federal banking agencies, including the Office of the Comptroller of the Currency (the “OCC”) and the Federal Reserve Board. Because domestic deposits in the Bank are insured (up to applicable limits) and certain deposits of the Bank and debt obligations of the Bank are temporarily guaranteed (up to applicable limits) by the FDIC, the FDIC also has certain regulatory and supervisory authority over the Bank under the Federal Deposit Insurance Act (the “FDIA”).
Regulatory Capital Standards and Related Matters
Bank holding companies are required to comply with the Federal Reserve Board's risk-based capital guidelines. The FDIC and the OCC have adopted risk-based capital ratio guidelines to which depository institutions under their respective supervision, such as the Bank, are subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk-weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk. The Corporation and the Bank met all risk-based capital requirements of the Federal Reserve Board, FDIC and OCC as of December 31, 2013.
Both federal and state law extensively regulate various aspects of the banking business, such as reserve requirements, truth-in-lending and truth-in-savings disclosures, equal credit opportunity, fair credit reporting, trading in securities and other aspects of banking operations. To the extent statutory or regulatory provisions are described in this section, such descriptions are qualified in their entirety by reference to the particular statutory or regulatory provisions.
The Corporation and the Bank are subject to the Federal Reserve Act, which restricts financial transactions between banks and affiliated companies. The statute limits credit transactions between banks, affiliated companies and its executive officers and its affiliates. The statute prescribes terms and conditions for bank affiliate transactions deemed to be consistent with safe and sound banking practices, and restrict the types of collateral security permitted in connection with a bank's extension of credit to an affiliate. Additionally, all transactions with an affiliate must be on terms substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with nonaffiliated parties.
Dodd-Frank Act
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law, which significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act, together with the related regulations that have been or are to be implemented, includes provisions affecting large and small financial institutions alike, including several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.
The Dodd-Frank Act, among other things, imposes enhanced capital requirements on bank holding companies; changed the base for FDIC insurance assessments to a bank's average consolidated total assets minus average tangible equity, rather than upon its deposit base, and permanently raised the standard deposit insurance limit to $250,000; and expands the FDIC's authority to raise insurance premiums. The legislation also calls for the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by September 30, 2020 and to “offset the effect” of increased assessments on insured depository institutions with assets of less than $10 billion. The Dodd-Frank Act also limits interchange fees payable on debit card transactions, establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products,


2


residential mortgages, home-equity loans and credit cards, and contains provisions on mortgage-related matters such as steering incentives, determinations as to a borrower's ability to repay and prepayment penalties. The Dodd-Frank Act also includes provisions that affect corporate governance and executive compensation at all publicly-traded companies and allows financial institutions to pay interest on business checking accounts. The law also restricts proprietary trading, places restrictions on the owning or sponsoring of hedge and private equity funds, and regulates the derivatives activities of banks and their affiliates. In addition, the law restricts the amount of trust preferred securities that may be considered Tier 1 capital. For depository institution holding companies with total assets of less than $15 billion, such as the Corporation, trust preferred securities issued before May 19, 2010 may continue to be included in Tier 1 capital, but future issuances of trust preferred securities will no longer be eligible for treatment as Tier 1 capital.
Because many aspects of this legislation have been only recently implemented, or continue to be subject to intensive agency rulemaking and subsequent public comment prior to implementation, which may occur over the next 12 months or more, it is difficult to predict at this time the ultimate effect of the Dodd-Frank Act on the Corporation.
Federal Deposit Insurance Act
Deposit Insurance Coverage Limits.    As a result of the Dodd-Frank Act, the FDIC standard maximum depositor insurance coverage limit has been permanently increased to $250,000.
Deposit Insurance Assessments.    Substantially all of the Bank's domestic deposits are insured up to applicable limits by the FDIC. Accordingly, the Bank is subject to deposit insurance premium assessments by the FDIC. In February 2011, the FDIC approved an amendment to its deposit insurance assessment regulations. The rule implements a provision in the Dodd-Frank Act that changes the assessment base for deposit insurance premiums from one based on domestic deposits to one based on average consolidated total assets minus average Tier 1 capital. The rule also changes the assessment rate schedules for insured depository institutions so that approximately the same amount of revenue would be collected under the new assessment base as would be collected under the current rate schedule and the schedules previously proposed by the FDIC.
FICO Assessments.    Since 1997, all FDIC-insured depository institutions have been required through assessments collected by the FDIC to service the annual interest on 30-year noncallable bonds issued by the Financing Corporation (“FICO”) in the late 1980s to fund losses incurred by the former Federal Savings and Loan Insurance Corporation. FICO assessments are separate from and in addition to deposit insurance assessments, are adjusted quarterly and, unlike deposit insurance assessments, are assessed uniformly without regard to an institution's risk category.
Conservatorship and Receivership of Institutions.    If any insured depository institution becomes insolvent and the FDIC is appointed its conservator or receiver, the FDIC may, under federal law, disaffirm or repudiate any contract to which such institution is a party, if the FDIC determines that performance of the contract would be burdensome, and that disaffirmance or repudiation of the contract would promote the orderly administration of the institution's affairs. Such disaffirmance or repudiation would result in a claim by its holder against the receivership or conservatorship. The amount paid upon such claim would depend upon, among other factors, the amount of receivership assets available for the payment of such claim and its priority relative to the priority of others. In addition, the FDIC as conservator or receiver may enforce most contracts entered into by the institution notwithstanding any provision providing for termination, default, acceleration, or exercise of rights upon or solely by reason of insolvency of the institution, appointment of a conservator or receiver for the institution, or exercise of rights or powers by a conservator or receiver for the institution. The FDIC as conservator or receiver also may transfer any asset or liability of the institution without obtaining any approval or consent of the institution's shareholders or creditors.
Depositor Preference.    The FDIA provides that, in the event of the liquidation or other resolution of an insured depository institution, the claims of its depositors (including claims by the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as receiver would be afforded a priority over other general unsecured claims against such an institution. If an insured depository institution fails, insured and uninsured depositors along with the FDIC will be placed ahead of unsecured, nondeposit creditors, including a parent holding company and subordinated creditors, in order of priority of payment.
Prompt Corrective Action.    The “prompt corrective action” provisions of the FDIA create a statutory framework that applies a system of both discretionary and mandatory supervisory actions indexed to the capital level of FDIC-insured depository institutions. These provisions impose progressively more restrictive constraints on operations, management, and capital distributions of the institution as its regulatory capital decreases, or in some cases, based on supervisory information other than the institution's capital level. This framework and the authority it confers on the federal banking agencies supplement other existing authority vested in such agencies to initiate supervisory actions to address capital deficiencies. Moreover, other provisions of law and regulation employ regulatory capital level designations the same as or similar to those established by the prompt corrective action provisions both in imposing certain restrictions and limitations and in conferring certain economic and other benefits upon institutions. These include restrictions on brokered deposits, limits on exposure to interbank liabilities, determination of risk-based FDIC deposit insurance premium assessments, and action upon regulatory applications.


3


Basel III
Internationally, both the Basel Committee on Banking Supervision and the Financial Stability Board (established in April 2009 by the Group of Twenty (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation and transparency) have committed to raise capital standards and liquidity buffers within the banking system (“Basel III”). In July of 2013 the respective U.S. federal banking agencies issued final rules implementing Basel III and the Dodd-Frank Act capital requirements to be fully phased in on a global basis on January 1, 2019. The new regulations establish a new tangible common equity capital requirement, increase the minimum requirement for the current Tier 1 risk-weighted asset (“RWA”) ratio, phase out certain kinds of intangibles treated as capital and certain types of instruments and change the risk weightings of certain assets used to determine required capital ratios. The new common equity Tier 1 capital component requires capital of the highest quality - predominantly composed of retained earnings and common stock instruments. For community banks such as the Bank, a common equity Tier 1 capital ratio 4.5% will become effective on January 1, 2015. The new capital rules will also increase the current minimum Tier 1 capital ratio from 4.0% to 6.0% beginning on January 1, 2015. In addition, institutions that seek the freedom to make capital distributions and pay discretionary bonuses to executive officers without restriction must also maintain greater than 2.5% in common equity attributable to a capital conservation buffer to be phased in from January 1, 2016 until January 1, 2019. The new rules also increase the risk weights for several categories of assets, including an increase from 100% to 150% for certain acquisition, development and construction loans and more than 90-day past due exposures. The new capital rules maintain the general structure of the prompt corrective action rules, but incorporate the new common equity Tier 1 capital requirement and the increased Tier 1 RWA requirement into the prompt corrective action framework.
Volcker Rule
On December 10, 2013, five financial regulatory agencies, including the Corporation’s primary federal regulators the Federal Reserve Board and the OCC, adopted final rules (the “Final Rules”) implementing the so-called Volcker Rule embodied in Section 13 of the Bank Holding Company Act, which was added by Section 619 of the Dodd-Frank Act. The Final Rules complete the process begun in October of 2011 when the agencies introduced proposed implementing rules for comment. The Final Rules prohibit banking entities from (1) engaging in short-term proprietary trading for their own accounts, and (2) having certain ownership interests in and relationships with hedge funds or private equity funds (“covered funds”). The Final Rules are intended to provide greater clarity with respect to both the extent of those primary prohibitions and of the related exemptions and exclusions. The Final Rules also require each regulated entity to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include (for the largest entities) making regular reports about those activities to regulators. Community and small banks are afforded some relief under the Final Rules. If such banks are engaged only in exempted proprietary trading, such as trading in U.S. government, agency, state and municipal obligations, they are exempt entirely from compliance program requirements. Moreover, even if a community or small bank engages in proprietary trading or covered fund activities under the rule, they need only incorporate references to the Volcker Rule into their existing policies and procedures. The Final Rules are effective April 1, 2014, but the conformance period has been extended from its statutory end date of July 21, 2014 until July 21, 2015. Beginning June 30, 2014, banking entities with $50 billion or more in trading assets and liabilities must report quantitative metrics; on April 30, 2016, banking entities with at least $25 billion but less than $50 billion must report; and on December 31, 2016, banking entities with at least $10 billion but less than $25 billion must report. The Corporation is currently evaluating the Final Rules, which are lengthy and detailed, but does not at this time expect the Final Rules to have a material impact on its operations.
USA PATRIOT Act
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) and the federal regulations issued pursuant to it substantially broaden previously existing anti-money laundering law and regulation, increase compliance, due diligence and reporting obligations for financial institutions, create new crimes and penalties, and require the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties in combating money laundering activities.
Employees
As of December 31, 2013, the Corporation employed 267 full-time equivalent employees. The Corporation is not a party to any collective bargaining agreement. Management considers its relationship with its employees to be good. Employee benefits programs are considered by the Corporation to be competitive with benefits programs provided by other financial institutions and major employers within the current market area.
Industry Segments
The Corporation and the Bank are engaged in one line of business, which is banking services. See Item 8, “Financial Statements and Supplementary Data” for financial information regarding the Corporation's business.


4


Available Information
LNB Bancorp, Inc.'s internet website is www.4LNB.com. Copies of the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are made available through this website or directly through the Securities and Exchange Commission (the “SEC”) website which is www.sec.gov.

 
Forward-Looking Statements
This Form 10-K contains forward-looking statements within the meaning of the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995. Terms such as “will,” “should,” “plan,” “intend,” “expect,” “continue,” “believe,” “anticipate” and “seek,” as well as similar comments, are forward-looking in nature. Actual results and events may differ materially from those expressed or anticipated as a result of risks and uncertainties which include but are not limited to:

a worsening of economic conditions or slowing of any economic recovery, which could negatively impact, among other things, business activity and consumer spending and could lead to a lack of liquidity in the credit markets;
changes in the interest rate environment which could reduce anticipated or actual margins;
increases in interest rates or weakening of economic conditions that could constrain borrowers' ability to repay outstanding loans or diminish the value of the collateral securing those loans;
market conditions or other events that could negatively affect the level or cost of funding, affecting the Corporation's ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth, and new business transactions at a reasonable cost, in a timely manner and without adverse consequences;
changes in political conditions or the legislative or regulatory environment, including new or heightened legal standards and regulatory requirements, practices or expectations, which may impede profitability or affect the Corporation's financial condition (such as, for example, the Dodd-Frank Act and rules and regulations that have been or may be promulgated under the Act);
persisting volatility and limited credit availability in the financial markets, particularly if market conditions limit the Corporation's ability to raise funding to the extent required by banking regulators or otherwise;
significant increases in competitive pressure in the banking and financial services industries, particularly in the geographic or business areas in which the Corporation conducts its operations;
limitations on the Corporation's ability to return capital to shareholders, including the ability to pay dividends, and the dilution of the Corporation's common shares that may result from, among other things, any capital-raising or acquisition activities of the Corporation;
adverse effects on the Corporation's ability to engage in routine funding transactions as a result of the actions and commercial soundness of other financial institutions;
general economic conditions becoming less favorable than expected, continued disruption in the housing markets and/or asset price deterioration, which have had and may continue to have a negative effect on the valuation of certain asset categories represented on the Corporation's balance sheet;
increases in deposit insurance premiums or assessments imposed on the Corporation by the FDIC;
a failure of the Corporation's operating systems or infrastructure, or those of its third-party vendors, that could disrupt its business;
risks that are not effectively identified or mitigated by the Corporation's risk management framework; and
difficulty attracting and/or retaining key executives and/or relationship managers at compensation levels necessary to maintain a competitive market position; as well as the risks and uncertainties described from time to time in the Corporation's reports as filed with the SEC.
The Corporation undertakes no obligation to update or clarify forward-looking statements, whether as a result of new information, future events or otherwise.

Item 1A.
Risk Factors
As a competitor in the banking and financial services industries, the Corporation and its business, operations and financial condition are subject to various risks and uncertainties. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K and in the Corporation's other filings with the SEC,


5


before making any investment decision with respect to the Corporation's securities. In particular, you should consider the discussion contained in Item 7 of this Annual Report on Form 10-K, which contains Management's Discussion and Analysis of Financial Condition and Results of Operations.
The risks and uncertainties described below may not be the only ones the Corporation faces. Additional risks and uncertainties not presently known by the Corporation or that the Corporation currently deems immaterial may also affect the Corporation's business. If any of these known or unknown risks or uncertainties actually occur or develop, the Corporation's business, financial condition, results of operations and future growth prospects could change. Under those circumstances, the trading prices of the Corporation's securities could decline, and you could lose all or part of your investment.
Economic trends have adversely affected the Corporation's industry and business and may continue to do so.
Difficult economic conditions over the last several years led to dramatic declines in the housing market that resulted in decreased home prices and increased delinquencies and foreclosures which negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans declined and may not recover. These general economic trends, the reduced availability of commercial credit and relatively high rates of unemployment all negatively impacted the credit performance of commercial and consumer credit and resulted in significant write-downs. Concerns over the stability of the financial markets and the economy resulted in decreased lending by financial institutions to their customers and to each other. This market uncertainty and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets adversely affected the Corporation's business, financial condition, results of operations and share price and, while the Corporation’s business has recovered to some extent, these economic and business conditions may still adversely affect us. Also, the Corporation's ability to assess the creditworthiness of customers and to estimate the losses inherent in its credit exposure is made more complex by these difficult market and economic conditions. Business activity across a wide range of industries and regions has been slow to recover and local governments and many companies continue to be adversely affected by a relative lack of consumer spending and liquidity in the credit markets. Any worsening of current conditions would have an adverse effect on the Corporation, its customers and the other financial institutions in its market. As a result, the Corporation may experience increases in foreclosures, delinquencies and customer bankruptcies.
Changes in interest rates could adversely affect the Corporation's earnings and financial condition.
The Corporation's earnings and cash flows depend substantially upon its net interest income. Net interest income is the difference between interest income earned on interest-earnings assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond the Corporation's control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Corporation receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect: (1) the Corporation's ability to originate loans and obtain deposits; (2) the fair value of the Corporation's financial assets and liabilities, including its securities portfolio; and (3) the average duration of the Corporation's interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rates indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Corporation's financial condition and results of operations.
The Corporation's allowance for loan losses may not be adequate to cover actual future losses.
The Corporation maintains an allowance for loan losses to cover probable and incurred loan losses. Every loan the Corporation makes carries a certain risk of non-repayment, and the Corporation makes various assumptions and judgments about the collectability of its loan portfolio including the creditworthiness of its borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. Through a periodic review and consideration of the loan portfolio, Management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with the Corporation. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond the Corporation's control, and these losses may exceed current estimates. The Corporation cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. If the Corporation's assumptions prove to be incorrect, its allowance for loan losses may not be sufficient to cover losses inherent in its loan portfolio, resulting in


6


additions to the allowance. Excessive loan losses and significant additions to the Corporation's allowance for loan losses could have a material adverse impact on its financial condition and results of operations.
Federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and could require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs.  Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.
Changes in economic and political conditions could adversely affect the Corporation's earnings.
The Corporation's success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond the Corporation's control may adversely affect its asset quality, deposit levels and loan demand and, therefore, its earnings. Because the Corporation has a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral and the Corporation's ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of the Corporation's borrowers to make timely repayments of their loans, which would have an adverse impact on the Corporation's earnings. If during a period of reduced real estate values the Corporation is required to liquidate the collateral securing a loan to satisfy the debt or to increase its allowance for loan losses, it could materially reduce the Corporation's profitability and adversely affect its financial condition. The substantial majority of the Corporation's loans are to individuals and businesses in Ohio. Consequently, significant declines in the economy in Ohio could have a material adverse effect on the Corporation's financial condition and results of operations. Furthermore, future earnings are susceptible to declining credit conditions in the markets in which the Corporation operates.
Certain industries, including the financial services industry, are disproportionately affected by certain economic indicators such as unemployment and real estate asset values. Should the improvement of these economic indicators lag the improvement of the overall economy, the Corporation could be adversely affected.
Should the stabilization of the U.S. economy continue, and lead to a further general economic recovery, the improvement of certain economic indicators, such as unemployment and real estate asset values and rents, may nevertheless continue to lag behind the overall economy. These economic indicators typically affect certain industries, such as real estate and financial services, more significantly. Furthermore, financial services companies with a substantial lending business are dependent upon the ability of their borrowers to make debt service payments on loans. Should unemployment or real estate asset values fail to recover for an extended period of time, the Corporation's results of operations could be negatively affected.
Strong competition may reduce the Corporation's ability to generate loans and deposits in its market.
The Corporation competes in a consolidating industry. A large part of the Corporation's competition continues to be large regional companies which have the capital resources to substantially impact such things as loan and deposit pricing, delivery channels and products. This may allow those companies to offer what may be perceived in the market as better pricing, better products and better convenience relative to smaller competitors like the Corporation, which could impact the Corporation's ability to grow its assets and earnings.
The Corporation's earnings and reputation may be adversely affected if credit risk is not properly managed.
Originating and underwriting loans is critical to the success of the Corporation. This activity exposes the Corporation to credit risk, which is the risk of losing principal and interest income because the borrower cannot repay the loan in full. The Corporation depends on collateral in underwriting loans, and the value of this collateral is impacted by interest rates and economic conditions.
The Corporation's earnings may be adversely affected if Management does not understand and properly manage loan concentrations. The Corporation's commercial loan portfolio is concentrated in commercial real estate. This includes significant commercial and residential development customers. This means that the Corporation's credit risk profile is dependent upon, not only the general economic conditions in the market, but also the health of the local real estate market. Certain of these loans are not fully amortized over the loan period, but have a balloon payment due at maturity. The borrower's ability to make a balloon payment typically will depend on being able to refinance the loan or to sell the underlying collateral. This factor, combined with others, including the Corporation's geographic concentration, can lead to unexpected credit deterioration and higher provisions for loan losses.


7


The Corporation is subject to liquidity risk.
Market conditions or other events could negatively affect the level or cost of funding, affecting the Corporation's ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner and without adverse consequences. Although Management has implemented strategies to maintain sufficient sources of funding to accommodate planned as well as unanticipated changes in assets and liabilities under both normal and adverse conditions, any substantial, unexpected and/or prolonged change in the level or cost of liquidity could adversely affect the Corporation's business, financial condition and results of operations.
As a result of the Dodd-Frank Act and international accords, financial institutions will become subject to new and increased capital and liquidity requirements. In light of these new requirements, it is possible that the Corporation could be required to increase its capital levels in the future above the levels in its current financial plans. These new requirements could have a negative impact on the Corporation's ability to lend, grow deposit balances or make acquisitions and on its ability to make capital distributions in the form of dividends or share repurchases. Higher capital levels could also lower the Corporation's return on equity.
Legislative or regulatory changes or actions, or significant litigation, could adversely impact the Corporation or the businesses in which it is engaged.
The financial services industry is extensively regulated. The Corporation is subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of its operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds, and not to benefit the Corporation's shareholders. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact the Corporation or its ability to increase the value of its business.
The US government has undertaken major reform of the financial services industry, including new efforts to protect consumers and investors from financial abuse. The Corporation expects to face further increased regulation of its industry as a result of current and future initiatives intended to provide economic stimulus, financial market stability and enhanced regulation of financial services companies and to enhance the liquidity and solvency of financial institutions and markets. The Corporation also expects in many cases more aggressive enforcement of regulations on both the federal and state levels. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. Additionally, actions by regulatory agencies or significant litigation against the Corporation could require it to devote significant time and resources to defending its business and may lead to penalties that materially affect the Corporation and its shareholders.
In July 2013, final rules were released regarding implementation of the Basel III regulatory capital rules for U.S. banking organizations. The rules substantially increase the complexity of capital calculations and the amount of required capital to be maintained. Specifically, the rules reduce the items that count as capital, establish higher capital ratios for all banks and increase risk weighting of a number of asset classes a bank holds. The potential impact of these rules includes, but is not limited to, reduced lending and negative pressure on profitability and return on equity due to the higher capital requirements. The cost of implementation and ongoing compliance with these rules may also negatively impact operating costs. To the extent the Corporation is required to increase capital in the future to comply with such rules, existing shareholders may be diluted and/or our ability to pay common share dividends may be reduced.
The Dodd-Frank Act may adversely affect the Corporation's business, financial conditions and results of operations.
The Dodd-Frank Act, which became law in July 2010, imposes significant restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with significant discretion, the effects of the Act on the Corporation's business will depend largely on the implementation of the Act by those agencies, and many of the details of the law have been only recently implemented, or remain in the process of being implemented and the effects they will have on the Corporation are difficult to predict.
Many of the provisions of the Dodd-Frank Act apply directly only to institutions much larger than the Corporation, and some will affect only institutions that engage in activities in which the Corporation does not engage. Among the changes to occur pursuant to the Dodd-Frank Act that can be expected to have an effect on the Corporation are the following:
The OTS has been merged into the OCC and the authority of the other remaining bank regulatory agencies restructured;
An independent Consumer Financial Protection Bureau has been established within the Federal Reserve Board, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws;
New trust preferred securities will no longer count toward Tier 1 capital;


8


The standard maximum amount of deposit insurance per customer is permanently increased to $250,000;
The deposit insurance assessment base calculation has been expanded to equal a depository institution's total assets minus the sum of its average tangible equity during the assessment period;
Corporate governance requirements applicable generally to all public companies in all industries have required or will require new compensation practices, including, but not limited to, requiring companies to “claw back” incentive compensation under certain circumstances, to provide shareholders the opportunity to cast a non-binding vote on executive compensation, to consider the independence of compensation advisors and new executive compensation disclosure requirements;
Establish new rules and restrictions regarding the origination of mortgages;
Permit the Federal Reserve to prescribe regulations regarding interchange transaction fees, and limit them to an amount reasonable and proportional to the cost incurred by the issuer for the transaction in question.
Many provisions of the Dodd-Frank Act remain subject to implementation and will require interpretation and rule making by federal regulators. The Corporation is closely monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations. While the ultimate effect of the Dodd-Frank Act on the Corporation cannot be determined yet, the law is likely to result in increased compliance costs and fees paid to regulators, along with possible restrictions on the Corporation's operations.
The Corporation may be adversely impacted by weakness in the local economies it serves.
The Corporation's business activities are geographically concentrated in Northeast Ohio and, in particular, Lorain County, Ohio, where commercial activity has deteriorated at a greater rate than in other parts of Ohio and in the national economy. The Corporation is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. This has led to and may lead to further unexpected deterioration in loan quality, slower asset and deposit growth, which may adversely affect the Corporation's operating results. Moreover, the Corporation cannot give any assurance that it will benefit from any market growth or favorable economic conditions in its primary market areas if they do occur.
Future FDIC premiums could be substantially higher and would have an unfavorable effect on earnings.
Higher levels of bank failures over the last few years have dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. In addition, the FDIC now insures deposit accounts up to $250,000 per customer (up from $100,000). These programs have placed additional stress on the deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased assessment rates of insured institutions. The Dodd-Frank Act also imposes additional assessments and costs with respect to deposits, requiring the FDIC to impose deposit insurance assessments based on total assets rather than total deposits. These announced increases, legislative and regulatory changes and any future increases or required prepayments of FDIC insurance premiums may adversely impact the Corporation's earnings and financial condition. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Corporation may be required to pay even higher FDIC premiums than the recently increased levels.
The soundness of other financial institutions could adversely affect the Corporation.
The Corporation's ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Corporation has exposure to many different industries and counterparties, and it routinely executes transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Corporation or by other institutions. Many of these transactions expose the Corporation to credit risk in the event of default of the Corporation's counterparty or client. In addition, the Corporation's credit risk may be exacerbated when the collateral held by it cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due the Corporation. There is no assurance that any such losses would not materially and adversely affect the Corporation's results of operations.
A failure of the Corporation's operating systems or infrastructure, or those of its third-party vendors, could disrupt its business.
The Corporation's business is dependent on its ability to process and monitor large numbers of daily transactions in compliance with legal and regulatory standards and the Corporation's product specifications, which it changes to reflect its business needs. As processing demands change and the Corporation's loan portfolios grow in both volume and differing terms and conditions, developing and maintaining the Corporation's operating systems and infrastructure becomes increasingly challenging and there


9


is no assurance that the Corporation can adequately or efficiently develop and maintain such systems. The Corporation's loan originations and conversions and the servicing, financial, accounting, data processing or other operating systems and facilities that support them may fail to operate properly or become disabled as a result of events that are beyond the Corporation's control, adversely affecting its ability to process these transactions. Any such failure could adversely affect the Corporation's ability to service its customers, result in financial loss or liability to its customers, disrupt its business, and result in regulatory action or cause reputational damage. Despite the plans and facilities the Corporation has in place, its ability to conduct business may be adversely affected by a disruption in the infrastructure that supports its businesses. This may include a disruption involving electrical, communications, internet, transportation or other services used by the Corporation or third parties with which it conducts business. Notwithstanding the Corporation's efforts to maintain business continuity, a disruptive event impacting its processing locations could adversely affect its business, financial condition and results of operations. The Corporation's operations rely on the secure processing, storage and transmission of personal, confidential and other information in its computer systems and networks. Although the Corporation takes protective measures, its computer systems, software and networks may be vulnerable to unauthorized access, computer viruses, malicious attacks and other events that could have a security impact beyond the Corporation's control. If one or more of such events occur, personal, confidential and other information processed and stored in, and transmitted through, the Corporation's computer systems and networks, could be jeopardized or otherwise interruptions or malfunctions in its operations could result in significant losses or reputational damage. The Corporation also routinely transmits and receives personal, confidential and proprietary information, some through third parties. The Corporation has put in place secure transmission capability, and works to ensure third parties follow similar procedures. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from a customer or third party could result in legal liability, regulatory action and reputational harm. In the event personal, confidential or other information is jeopardized, intercepted, misused or mishandled, the Corporation may be required to expend significant additional resources to modify its protective measures or to investigate and remediate vulnerabilities or other exposures, and it may be subject to fines, penalties, litigation costs and settlements and financial losses that are either not insured against or not fully covered through any insurance maintained by it. If one or more of such events occur, the Corporation's business, financial condition or results of operations could be significantly and adversely affected.

The Corporation is subject to risk from the failure of third party vendors.
The Corporation relies on other companies to provide components of the Corporation's business infrastructure. Third party vendors provide certain components of the Corporation's business infrastructure, such the Bank's processing and electronic banking systems, item processing and Internet connections. While the Corporation has selected these third party vendors carefully, it does not control their actions. Any problems caused by these third parties not providing the Corporation their services for any reason or their performing their services poorly, could adversely affect the Corporation's ability to deliver products and services to the Corporation's operations directly through interference with communications, including the interruption or loss of the Corporation's websites, which could adversely affect the Corporation's business, financial condition and results of operations.
The potential for fraud in the card payment industry is significant.
Issuers of prepaid and credit cards have suffered significant losses in recent years with respect to the theft of cardholder data that has been illegally exploited for personal gain. The theft of such information is regularly reported and affects not only individuals but businesses as well (albeit to a lesser degree). Many types of credit card fraud exist, including the counterfeiting of cards and “skimming.” “Skimming” is the term for a specialized type of credit card information theft whereby, typically, an employee of a merchant will copy the cardholder’s number and security code (either by handwriting the information onto a piece of paper, entering such information into a keypad or other device, or using a handheld device which “reads” and then stores the card information embedded in the magnetic strip). Once a credit card number and security code has been skimmed, the skimmer can use such information for purchases until the unauthorized use is detected either by the cardholder or the card issuer. Losses from fraud have been substantial for certain card industry participants. Although fraud has not had a material impact on the profitability of the Bank, it is possible that such activity could impact the Corporation at some time in the future.
The Corporation may have fewer resources than many of its competitors to invest in technological improvements.
 
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services.  The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs.  The Corporation's future success will depend, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in its operations.  Many of the Corporation's competitors have substantially greater resources to invest in technological improvements. The Corporation may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers.


10


Changes in accounting standards could materially impact the Corporation's financial statements.
The Financial Accounting Standards Board (FASB) may change the financial accounting and reporting standards that govern the preparation of the Corporation's financial statements. These changes can be difficult to predict and can materially impact how the Corporation records and reports it financial condition and results of operations.
The Corporation may not be able to attract and retain skilled people.
The Corporation's success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities in which the Corporation is engaged can be intense, and the Corporation may not be able to retain or hire the people it wants and/or needs. In order to attract and retain qualified employees, the Corporation must compensate its employees at market levels. If the Corporation is unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain its competitive position, the Corporation's performance, including its competitive position, could suffer, and, in turn, adversely affect the Corporation's business, financial condition and results of operations.
The Corporation's ability to pay dividends is subject to limitations.
Holders of the Corporation's common shares are only entitled to receive such dividends as the Board of Directors may declare out of funds legally available for such payments. Furthermore, the Corporation's common shareholders are subject to the prior dividend rights of holders of its preferred stock, to the extent any preferred stock is issued and outstanding, and any increase in the dividend is subject to Board approval and dependent upon numerous considerations relating to the capital position and needs of the corporation.
In September 2009, the Corporation reduced its quarterly dividend on its common shares to $0.01 per share. The Corporation could determine to eliminate its common shares dividend altogether. This could adversely affect the market price of the Corporation's common shares. Also, the Corporation is a bank holding company and its ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve Board regarding capital adequacy and dividends.
In addition, the terms of the Corporation's outstanding trust preferred securities prohibit it from declaring or paying any dividends or distributions on its capital stock, including its common shares, if an event of default has occurred and is continuing under the applicable indenture or if the Corporation has given notice of its election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing.
Additional capital may not be available to the Corporation if and when it is needed.
The Corporation and the Bank are subject to capital-based regulatory requirements. The ability of the Corporation and the Bank to meet capital requirements is dependent upon a number of factors, including results of operations, level of nonperforming assets, interest rate risk, future economic conditions, future changes in regulatory and accounting policies and capital requirements, and the ability to raise additional capital if and when it is needed. Certain circumstances, such as a reduction of capital due to losses from nonperforming assets or otherwise, could cause the Corporation or the Bank to become unable to meet applicable regulatory capital requirements, which may materially and adversely affect the Corporation's financial condition, liquidity and results of operations. In such an event, additional capital may be required to meet requirements. The Corporation's ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time which are outside its control, and on the Corporation's financial performance. Accordingly, additional capital, if needed, may not be available on terms acceptable to the Corporation. Furthermore, if any such additional capital is raised through the offering of equity securities, it may dilute the holdings of the Corporation's existing shareholders or reduce the market price of the Corporation's common shares, or both.
The Corporation's risk management framework may not effectively identify or mitigate its risks.
The Corporation's risk management framework seeks to mitigate risk and appropriately balance risk and return. The Corporation has established processes and procedures intended to identify, measure, monitor and report the types of risk to which it is subject, including credit risk, market risk, liquidity risk, operational risk, legal and compliance risk, and strategic risk. The Corporation seeks to monitor and control its risk exposure through a framework of policies, procedures and reporting requirements. Management of the Corporation's risks in some cases depends upon the use of analytical and/or forecasting models. If the models that the Corporation uses to mitigate these risks are inadequate, the Corporation may incur increased losses. In addition, there may be risks that exist, or that develop in the future, that the Corporation has not appropriately anticipated, identified or mitigated. If the Corporation's risk management framework does not effectively identify or mitigate its risks, it could suffer unexpected losses and could be materially adversely affected.


11


If the Corporation is required to write down goodwill recorded in connection with its acquisitions, the Corporation's profitability would be negatively impacted.
Applicable accounting standards require the Corporation to use the purchase method of accounting for all business combinations. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of the acquired company's net assets, the excess is carried on the acquirer's balance sheet as goodwill. At December 31, 2013, the Corporation had approximately $21.6 million of goodwill on its balance sheet. Goodwill must be evaluated for impairment at least annually. Write downs of the amount of any impairment, if necessary, are to be charged to the results of operations in the period in which the impairment occurs. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and related write downs, which would have an adverse effect on the Corporation's financial condition and results of operations.
Our compensation expense has increased and may increase substantially following the sale of the Corporation's Series B Preferred Stock by the United States Department of the Treasury and the subsequent retirement of the Series B Preferred Stock.
Following the United States Department of the Treasury's sale of the Corporation's Series B Preferred Stock, certain executive compensation restrictions and corporate governance standards, as set forth in the Interim Final Rule on TARP Standards for Compensation and Corporate Governance published June 15, 2009, became no longer applicable to the Corporation and the Corporation's compensation expense for its executive officers and other senior employees has increased and may increase substantially.
Item 1B.
Unresolved Staff Comments
Not applicable.



12


Item 2.
Properties
The Corporation's corporate offices are located at 457 Broadway, Lorain, Ohio. As of December 31, 2013, the Corporation and its subsidiaries operated a total of 27 facilities, including its banking centers, loan production offices, corporate offices, and maintenance, purchasing, operations and professional development centers, which are located in Lorain, eastern Erie, western Cuyahoga and Summit counties of Ohio, and its SBA-related loan origination office in Columbus, Ohio. Of these facilities, 13 were owned, including the corporate offices. The other 14 facilities were leased from unaffiliated third parties on varying lease terms. See Note 8 to the consolidated financial statements contained in Item 8, “Financial Statement and Supplementary Data.”

The 27 facilities and their addresses are listed in the following table:  

Main Banking Center & Corporate Offices
457 Broadway, Lorain
Vermilion
4455 East Liberty Avenue, Vermilion
Amherst
1175 Cleveland Avenue, Amherst
Lake Avenue
42935 North Ridge Road, Elyria Township
Avon
2100 Center Road, Avon
Avon Lake
32960 Walker Road, Avon Lake
Pearl Avenue
2850 Pearl Avenue, Lorain
Oberlin
24 East College Street, Oberlin
Ely Square
124 Middle Avenue, Elyria
Oberlin Avenue
3660 Oberlin Avenue, Lorain
Olmsted Township
27095 Bagley Road, Olmsted Township
Kendal at Oberlin
600 Kendal Drive, Oberlin
The Renaissance
26376 John Road, Olmsted Township
Chestnut Commons
105 Chestnut Commons Drive, Elyria
North Ridgeville
34085 Center Ridge Road, North Ridgeville
Village of LaGrange
546 North Center Street, LaGrange
Westlake Village
28550 Westlake Village Drive, Westlake
Wesleyan Village
807 West Avenue, Elyria
Morgan Bank
178 West Streetsboro Street, Hudson
Solon Mortgage Center
 34305 Solon Rd., Franklin's Row #30, Solon
Cuyahoga Loan Production Office
2 Summit Park Drive, Independence
Operations Center
2130 West Park Drive, Lorain
Maintenance Center
2140 West Park Drive, Lorain
Purchasing Center
2150 West Park Drive, Lorain
Professional Development Center
521 Broadway, Lorain
Sixth Street Drive-In
200 West 6th Street, Lorain
Columbus Loan Production Office

1890 Northwest Boulevard, Columbus


The Corporation also owns and leases equipment for use in its business. The Corporate headquarters at 457 Broadway is currently 75% occupied. The remaining space is expected to be utilized to accommodate future growth. The Corporation considers all its facilities to be in good condition, well-maintained and more than adequate to conduct the business of banking.
Item 3.
Legal Proceedings
The Corporation and Bank are subject to legal proceedings and claims which arise in the ordinary course of business. In the opinion of Management, the amount of ultimate liability with respect to these actions will not have a material adverse effect on the Corporation’s financial position or results of operations.




13


Item 4.
Mine Safety Disclosures
Not applicable.

Supplemental Item — Executive Officers of the Registrant
Pursuant to Form 10-K, General Instruction G(3), the following information on Executive Officers is included as an additional item in this Part I:
 
Name

Age 

Principal Occupation For Past Five Years

Positions and
Offices
Held with
LNB Bancorp, Inc.

Executive
Officer Since 

Daniel E. Klimas
55
President and Chief Executive Officer, LNB Bancorp, Inc., February 2005 to present. President, Northern Ohio Region, Huntington Bank from 2001 to February 2005.
President and Chief Executive
Officer
2005
 
 
 
 
 
Gary J. Elek
62
Chief Financial Officer, LNB Bancorp, Inc., from April 2009 to present. Vice President and Controller for North America of A. Schulman, Inc. in Akron, Ohio from 2006 to 2008. Corporate Controller of A. Schulman, Inc. from 2004 to 2006. Executive Vice President, Corporate Development from 1999 to 2004, as Senior Vice President, Corporate Development from 1997 to 1999 and as Senior Vice President and Treasurer from 1988 to 1997 of FirstMerit Corporation.
Chief Financial Officer and Principal Accounting Officer
2009
 
 
 
 
 
Michael Bickerton

54
Senior Vice President and Chief Credit Officer, LNB Bancorp, Inc., October 2013 to present. Executive Vice President, Credit & Risk Manager, Community Bank for KeyCorp from 2011 to 2013. Executive Vice President, Great Lakes Region Credit Executive for KeyCorp from 2006 to 2010. Executive Vice President, Credit Administration
Senior Vice President and Chief Credit Officer
2013
 
 
 
 
 
Kevin Nelson
50
Senior Vice President, LNB Bancorp, Inc., from April 2009 to present. Director of Indirect Lending, The Lorain National Bank, from May 2007 to present. Senior Vice President, Bank Sales and Loan Originations, Morgan Bank (a division of the Bank), from September 2006 to May 2007. President, Nelson Marketing Group, LLC, from November 2005 to September 2006.
Senior Vice President and Director of Indirect Lending
2009
 
 
 
 
 
Frank A. Soltis
61
Senior Vice President, LNB Bancorp, Inc., July 2005 to present. Senior Vice President, Lakeland Financial Corporation, 1997 to 2005.
Senior Vice President and Chief Information Officer

2005
 
 
 
 
 
Mary E. Miles
55
Senior Vice President, LNB Bancorp, Inc., April 2005 to present. President, Miles Consulting, Inc. from 2001 to 2005.
Senior Vice President and Director of Human Resources, Professional Development & Security
2005
 
 
 
 
 
John Simacek
61
Senior Vice President, LNB Bancorp, Inc., from April 2009 to present. Senior Retail Executive, The Lorain National Bank (a subsidiary of the Corporation), October 2005 to present. Vice President and Regional Manager of the Cleveland, Ohio affiliate of Fifth Third Bank, 1999 to October 2005.
Senior Vice President and Senior Retail Executive
2009
 
 
 
 
 
Robert F. Heinrich
60
Senior Vice President, LNB Bancorp, Inc., from April 2009 to present. Corporate Secretary, LNB Bancorp, Inc., from February 2008 to Present. Director of Risk Management, LNB Bancorp, Inc., from 2005 to present. Controller, LNB Bancorp, Inc., from January 2004 to March 2005. Auditor, LNB Bancorp, Inc., from May 2003 to January 2004.
Senior Vice President, Corporate Secretary and Director of Risk Management
2009
 
 
 
 
 
Peter R. Catanese
57
Senior Vice President and Marketing Director, LNB Bancorp, Inc., from September 2005 to present. Vice President, Charter One Bank, May 1998 to September 2005.
Senior Vice President and Director of Marketing
2011




14


PART II 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information; Equity Holders; Dividends.    LNB Bancorp, Inc. common shares, par value $1.00 per share, are traded on The NASDAQ Stock Market® under the ticker symbol “LNBB”. The prices below represent the high and low sales prices reported on The NASDAQ Stock Market for each specified period. All prices reflect inter-dealer prices without markup, markdown or commission and may not necessarily represent actual transactions.
LNB Bancorp, Inc. has paid a cash dividend to shareholders each year since becoming a holding company in 1984. At present, the Corporation expects to pay cash dividends to shareholders in an amount equal to $0.01 per share if approved by the Board of Directors. The terms of the Corporation's outstanding trust preferred securities prohibit it from declaring or paying any dividends or distributions on its capital stock, including its common shares, if an event of default has occurred and is continuing under the applicable indenture or if the Corporation has given notice of its election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing.
The common shares of LNB Bancorp, Inc. are usually listed in publications as “LNB Bancorp”. LNB Bancorp Inc.’s common stock CUSIP is 502100100.
As of February 26, 2014, LNB Bancorp, Inc. had 1,733 shareholders of record and the closing price per share of the Corporation’s common shares was $11.14.
Common Stock Trading Ranges and Cash Dividends Declared
 
 
2013
 
High
 
Low
 
Cash
Dividends
Declared
Per Share
First Quarter
$
8.65

 
$
5.90

 
$
0.01

Second Quarter
9.87

 
8.02

 
0.01

Third Quarter
10.00

 
8.53

 
0.01

Fourth Quarter
10.60

 
9.07

 
0.01

 
 
 
 
 
 
 
2012
 
High
 
Low
 
Cash
Dividends
Declared
Per Share
First Quarter
$
7.34

 
$
4.60

 
$
0.01

Second Quarter
6.93

 
6.00

 
0.01

Third Quarter
6.75

 
5.46

 
0.01

Fourth Quarter
6.70

 
5.78

 
0.01




15


The following graph shows a five-year comparison of cumulative total returns for LNB Bancorp, the Standard & Poor’s 500 Stock Index© and the Nasdaq Bank Index.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among LNB Bancorp, Inc., The S&P 500 Index
And The NASDAQ Bank Index
 
*
$100 invested on 12/31/08 in stock or index. Including reinvestment of dividends. Fiscal year ending December 31.
The graph shown above is based on the following data points:
 
 
12/08
 
12/09
 
12/10
 
12/11
 
12/12
 
12/13
LNB Bancorp, Inc. 
$100.00
 
$85.63
 
$99.58
 
$94.94
 
$119.96
 
$204.83
S&P 500 Index
100.00
 
126.46
 
145.51
 
148.59
 
172.37
 
228.19
NASDAQ Bank Index
100.00
 
84.86
 
97.62
 
87.11
 
102.06
 
144.32


16


Issuer Purchases of Equity Securities
The following table summarizes common share repurchase activity for the quarter ended December 31, 2013:
 
Period
Total Number of
Shares  (or Units)
Purchased
 
Average Price Paid
Per  Share (or Unit)
 
Total Number of
Shares  (or Units)
Purchased as
Part of Publicly
Announced Plans
or Programs
 
Maximum
Number of
Shares (or Units)
that may yet be
Purchased Under
the Plans or Programs (1)
October 1, 2013 — October 31, 2013

 
n/a
 

 
129,500

November 1, 2013 — November 30, 2013

 
n/a
 

 
129,500

December 1, 2013 — December 31, 2013

 
n/a
 

 
129,500

Total

 
n/a
 

 
129,500

(1) On July 28, 2005, the Corporation announced a share repurchase program of up to 5 percent, or about 332,000, of its common shares outstanding. Repurchased shares can be used for a number of corporate purposes, including the Corporation’s stock option and employee benefit plans. The share repurchase program provides that share repurchases are to be made primarily on the open market from time-to-time until the 5 percent maximum is repurchased or the earlier termination of the repurchase program by the Board of Directors, at the discretion of management based upon market, business, legal and other factors. As of December 31, 2013, the Corporation had repurchased an aggregate of 202,500 shares under this program. No shares were repurchased under this program during 2013.
During the fourth quarter of 2013, the Corporation issued a notice to redeem all of its 9,147 outstanding shares of Series B Preferred Stock. On January 17, 2014, the Corporation completed the repurchase and redemption of all of the Series B Preferred Stock for an aggregate price of $9,147,000, the face liquidation amount of the shares, plus approximately $74,000 of accrued but unpaid dividends.



17


Item 6.
Selected Financial Data
 
Year Ended December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
 
(Dollars in thousands except share and per share amounts and ratios)
Total interest income
$
41,679

 
$
45,948

 
$
49,349

 
$
51,372

 
$
57,647

Total interest expense
6,156

 
7,509

 
10,108

 
12,764

 
19,925

Net interest income
35,523

 
38,439

 
39,241

 
38,608

 
37,722

Provision for Loan Losses
4,375

 
7,242

 
10,353

 
10,225

 
19,017

Other income
9,616

 
10,075

 
9,987

 
10,290

 
10,180

Net gain on sale of assets
2,510

 
1,672

 
1,428

 
1,277

 
1,776

Gain on extinguishment of debt

 

 

 
2,210

 

Other expenses
35,187

 
34,903

 
34,144

 
35,569

 
35,330

Income (loss) before income taxes
8,087

 
8,041

 
6,159

 
6,591

 
(4,669
)
Income tax (benefit)
1,926

 
1,934

 
1,156

 
1,226

 
(2,668
)
Net income (loss)
6,161

 
6,107

 
5,003

 
5,365

 
(2,001
)
Preferred stock dividend and accretion
646

 
1,266

 
1,276

 
1,276

 
1,256

Net income (loss) available to common shareholders
$
5,515

 
$
4,841

 
$
3,727

 
$
4,089

 
$
(3,257
)
Cash dividend declared
$
359

 
$
317

 
$
315

 
$
304

 
$
1,459

Per Common Share(1)


 

 

 

 

Basic earnings (loss)
$
0.61

 
$
0.61

 
$
0.47

 
$
0.55

 
$
(0.45
)
Diluted earnings (loss)
0.61

 
0.61

 
0.47

 
0.55

 
(0.45
)
Cash dividend declared
0.04

 
0.04

 
0.04

 
0.04

 
0.20

Book value per share
$
10.73

 
$
11.50

 
$
11.18

 
$
10.75

 
$
10.84

Financial Ratios

 

 

 

 

Return on average assets
0.51
%
 
0.51
%
 
0.43
%
 
0.46
%
 
(0.17
)%
Return on average common equity
5.62

 
5.29

 
4.47

 
4.97

 
(1.86
)
Net interest margin (FTE)(2)
3.19

 
3.49

 
3.67

 
3.60

 
3.39

Efficiency ratio
72.88

 
68.71

 
66.69

 
70.18

 
70.37

Period end loans to period end deposits
86.30

 
88.29

 
85.07

 
83.04

 
82.68

Dividend payout
6.56

 
6.56

 
8.46

 
7.28

 
            n/a

Average shareholders’ equity to average assets
9.02

 
9.65

 
9.58

 
9.32

 
8.99

Net charge-offs to average loans
0.51

 
0.77

 
1.14

 
1.62

 
1.46

Allowance for loan losses to period end total loans
1.94

 
2.00

 
2.02

 
1.99

 
2.34

Nonperforming loans to period end total loans
2.44

 
3.15

 
4.09

 
5.15

 
4.84

Allowance for loan losses to nonperforming loans
79.62

 
63.45

 
49.50

 
38.57

 
48.39

At Year End

 

 

 

 

Cash and cash equivalents
$
52,272

 
$
30,659

 
$
40,647

 
$
48,220

 
$
26,933

Securities and interest-bearing deposits
216,122

 
203,763

 
226,012

 
222,073

 
255,841

Restricted stock
5,741

 
5,741

 
5,741

 
5,741

 
4,985

Loans held for sale
4,483

 
7,634

 
3,448

 
5,105

 
3,783

Gross loans
902,299

 
882,548

 
843,088

 
812,579

 
803,197

Allowance for loan losses
17,505

 
17,637

 
17,063

 
16,136

 
18,792

Net loans
884,794

 
864,911

 
826,025

 
796,443

 
784,405

Other assets
66,845

 
65,546

 
66,549

 
74,955

 
73,562

Total assets
1,230,257

 
1,178,254

 
1,168,422

 
1,152,537

 
1,149,509

Total deposits
1,045,589

 
999,592

 
991,080

 
978,526

 
971,433

Other borrowings
67,522

 
63,861

 
58,962

 
59,671

 
64,582

Other liabilities
5,690

 
4,657

 
5,106

 
4,876

 
9,353

Total liabilities
1,118,801

 
1,068,110

 
1,055,148

 
1,043,073

 
1,045,368

Total shareholders’ equity
111,456

 
110,144

 
113,274

 
109,464

 
104,141

Total liabilities and shareholders’ equity
$
1,230,257

 
$
1,178,254

 
$
1,168,422

 
$
1,152,537

 
$
1,149,509

(1)
Basic and diluted earnings (loss) per share are computed using the weighted-average number of shares outstanding during each year.
(2)
Tax exempt income was converted to a fully taxable equivalent basis at a 34% statutory Federal income tax rate for years presented.


18


Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following commentary presents a discussion and analysis of the Corporation’s financial condition and results of operations by its management. The review highlights the principal factors affecting earnings for 2013, 2012 and 2011 and significant changes in the balance sheet for 2013 and 2012. Financial information for the prior five years is presented where appropriate. The objective of this financial review is to enhance the reader’s understanding of the accompanying tables and charts, the consolidated financial statements, notes to the financial statements and financial statistics appearing elsewhere in the report. Where applicable, this discussion also reflects management’s insights of known events and trends that have or may reasonably be expected to have a material effect on the Corporation’s operations and financial condition.

Summary of Significant Transactions and Events
The following is a summary of transactions or events that have impacted the Corporations’ results of operations or financial condition during the 2013 fiscal year:
On March 15, 2013, the Corporation issued an aggregate of 1,359,348 of its common shares at a price of $7.16 per share in exchange for an aggregate of 9,733 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”) at a price of 100% of the face liquidation amount of the shares, or $1,000 per share. The Series B Preferred Stock was originally issued by the Corporation in December 2008 as part of the U.S. Department of the Treasury’s Capital Purchase Program. The Treasury sold all of the Series B Preferred Stock to private investors through a modified Dutch auction that was completed in June 2012.
In the first quarter of 2013, the Corporation incurred $712,000 in expenses for the establishment of a supplemental executive retirement plan (“SERP”) for the Chief Executive Officer. The Corporation has established and funded a Rabbi Trust to accumulate funds in order to satisfy the contractual liability of these supplemental retirement plan benefits.
On September 27, 2013, the Bank named James Baemel Senior Vice President & Small Business Administration (“SBA”) Lending Manager. In his newly created position, Mr. Baemel will be responsible for leading the recently developed SBA commercial lending sales team at the Bank, which will serve businesses across a nine state area. Mr. Baemel and his team will be located in a new loan office in Columbus, OH. The Corporation believes this new strategic effort will provide the ability to source SBA loans across a much larger market area than Northeast Ohio and drive revenue growth.
During the fourth quarter of 2013, the Corporation introduced “Mobile LNB." The Corporation is excited to offer its customers the convenience to securely access their accounts at any time and from anywhere via their mobile device.
As described in Note 17 of the Notes to the Consolidated Financial Statements, the Corporation incurred settlement charges of $153,000 during 2013 due to the aggregate amount of lump sum distributions to participants in the Corporations’ defined benefit pension plan, which was frozen December 31, 2002.
During the fourth quarter of 2013, the Corporation, in connection with funding the retirement of Series B Preferred Stock, completed the sale of newly issued common shares to certain institutional investors, other third-party investors and certain directors of the Corporation in a private placement for approximately $3.68 million in gross proceeds. The Corporation issued an aggregate of 367,321 of its common shares at a price of $9.91 per share to the third-party investors and $10.30 per share to the directors.
On December 17, 2013, the Corporation issued a notice to redeem all 7,689 of the then-outstanding shares of Series B Preferred Stock. On January 17, 2014, the Corporation completed its repurchase and redemption of those shares for an aggregate price of $9,147,000, the face liquidation amount of the shares, plus approximately $74,000 of accrued but unpaid dividends.


19


Executive Overview (Dollars in thousands, except per share data)
Net income available to common shareholders for the year ended December 31, 2013 was $5,515, compared to $4,841 in 2012 and $3,727 in 2011, representing earnings per diluted common share of $0.61, $0.61 and $0.47, respectively. From December 31, 2011 to December 31, 2013, net income available to common shareholders has increased $1,788, or 48.0%, which is primarily attributable to improved asset quality and the gradual reduction and complete redemption on January 17, 2014 of the Corporations’ Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”). The Corporation expects to save approximately $777,500 in dividends that otherwise would have been payable on the Series B Preferred Stock during 2014, in addition to the savings already realized due to the strategically timed partial redemptions.
The Corporation recorded a loan loss provision of $4,375 in 2013 compared to $7,242 in 2012, and $10,353 in 2011, as asset quality improved substantially. At December 31, 2013 non-performing loans were $21,986 compared to $27,796 in 2012 and $34,471 in 2011. This is a decrease of 20.9% year over year and 36.2% from 2011. Net charge-offs were $4,507 at December 31, 2013 compared to $6,668 in 2012, and $9,426 in 2011 representing decreases of 32.4% from 2012 and 52.2% from 2011. The allowance for loan losses at December 31, 2013 was $17,505 compared to $17,637 in 2012 and $17,063 in 2011.
Net interest income for the year ended December 31, 2013 was $35,523 compared to $38,439 in 2012 and $39,241 in 2011. The Corporation continues to see net interest margin pressure due to the historically low interest rate environment and increased competition in the Corporations markets. The net interest margin on a fully tax-equivalent (FTE) basis decreased to 3.19% at December 31, 2013 compared to 3.49% in 2012 and 3.67% in 2011.
Total noninterest income for the year ended December 31, 2013 was $12,126, an increase of 3.2% from $11,747 in 2012 and an increase of 6.2% from $11,415 in 2011. The largest component of noninterest income is deposit and other service charges and fees which remained consistent year over year at $6,788 and $6,893 for 2013 and 2012, respectively, but down from the year ended December 31, 2011 of $7,325. The most prominent growth occurred in the gain on the sale of loans. Gain on the sale of loans for the year ended December 31, 2013 was $2,324 compared to $1,575 in 2012, and $889 in 2011. The Corporation’s SBA initiative implemented in the fourth quarter of 2013, recognized a $531 gain on the sale of SBA loans. The Corporation believes future revenue growth in this new sales strategy will be recognized in 2014.
For the year ended December 31, 2013, total noninterest expense was $35,187, compared to $34,903 and $34,144 in 2012 and 2011, respectively. The year over year increase in noninterest expense was primarily attributable to a 7.7% increase in salaries and employee benefits. During 2013, the Corporation recognized a $712 expense due to the establishment of the Supplemental Executive Retirement Plan, $153 in settlement charges due to the aggregate amount of lump sum distributions to participants in the Corporations defined benefit pension plan and increases associated with the launch of the Corporations newly formed SBA lending team. Other operating expenses were generally controlled as reduced FDIC insurance costs and other real estate owned expenses helped to offset the salary and employee benefits increase.
Total assets were $1,230,257 at December 31, 2013, an increase of 4.4%, compared to $1,178,254 at December 31, 2012. The growth was primarily attributable to increases in gross portfolio loans and total investment securities. Gross portfolio loans increased year over year by $19,751, or 2.2%. Comparing December 31, 2013 to December 31, 2012, the most notable growth occurred in commercial and industrial loans, which increased 29.0% to $88,646 from $68,705; consumer loans, which increased 33.5% to $16,156 from $12,101; and indirect loans which increased by $6,399, or 3.2%, to $206,323. Total investment securities at December 31, 2013 were $216,122, an increase of 6.1%, from $203,763 at December 31, 2012.
At December 31, 2013, total liabilities increased 4.7% to $1,118,801 from $1,068,110 at December 31, 2012, primarily as a result of an increase in total deposits and short-term borrowings. Total deposits increased $45,997 to $1,045,589 at December 31, 2013 compared to $999,592 at December 31, 2012. Year over year increases were noted in all deposit categories; demand and other noninterest-bearing deposits increased by 6.5%, savings, money market and interest bearing demand increased by 4.4%, and time deposits increased by 4.2%. Short-term borrowings increased to $4,576 at December 31, 2013 compared to $1,115 at year-end 2012, due to approximately $3,000 in borrowings in December 2013 under a line of credit with an unaffiliated financial institution as part of the Corporations retirement of Series B Preferred Stock.
Total shareholders’ equity at December 31, 2013 was $111,456, an increase of 1.2% from $110,144 at year-end 2012. Series B Preferred Stock equity decreased to $7,689 at December 31, 2013 compared to $18,880 at year-end 2012. Common stock equity at December 31, 2013, increased to $10,002 from $8,273 at December 31, 2012.





20


Table 1: Condensed Consolidated Average Balance Sheets
Interest, Rate, and Rate/ Volume differentials are stated on a Fully-Tax Equivalent (FTE) Basis.
Table 1 presents the condensed consolidated average balance sheets for the three years ended December 31, 2013December 31, 2012 and December 31, 2011.
 
 
Year ended December 31,
 
2013
 
2012
 
2011
 
Average
Balance
 
Interest
 
Rate
 
Average
Balance
 
Interest
 
Rate
 
Average
Balance
 
Interest
 
Rate
 
(Dollars in thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Govt agencies and
corporations
$
185,003

 
$
3,774

 
2.04
%
 
$
194,967

 
$
4,677

 
2.40
%
 
$
204,308

 
$
5,847

 
2.86
%
State and political subdivisions
32,879

 
1,705

 
5.19

 
31,859

 
1,656

 
5.20

 
25,612

 
1,490

 
5.82

Federal funds sold and short-term investments
15,759

 
28

 
0.18

 
11,422

 
35

 
0.31

 
21,574

 
57

 
0.26

Restricted stock
5,741

 
277

 
4.82

 
5,741

 
285

 
4.96

 
5,741

 
277

 
4.82

Commercial loans
490,218

 
21,900

 
4.47

 
481,875

 
23,421

 
4.86

 
454,210

 
23,937

 
5.27

Residential real estate loans
50,801

 
2,597

 
5.11

 
56,412

 
3,007

 
5.33

 
60,804

 
3,380

 
5.56

Home equity lines of credit
107,812

 
4,113

 
3.81

 
108,125

 
4,280

 
3.96

 
109,217

 
4,255

 
3.90

Installment loans
244,301

 
7,918

 
3.24

 
227,086

 
9,198

 
4.05

 
203,946

 
10,650

 
5.22

Total Earning Assets
$
1,132,514

 
$
42,312

 
3.74
%
 
$
1,117,487

 
$
46,559

 
4.17
%
 
$
1,085,412

 
$
49,893

 
4.60
%
Allowance for loan loss
(17,789
)
 
 
 
 
 
(17,461
)
 
 
 
 
 
(17,317
)
 
 
 
 
Cash and due from banks
35,942

 
 
 
 
 
29,951

 
 
 
 
 
30,263

 
 
 
 
Bank owned life insurance
18,934

 
 
 
 
 
18,180

 
 
 
 
 
17,470

 
 
 
 
Other assets
46,627

 
 
 
 
 
47,846

 
 
 
 
 
51,833

 
 
 
 
Total Assets
$
1,216,228

 
 
 
 
 
$
1,196,003

 
 
 
 
 
$
1,167,661

 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer time deposits
$
434,771

 
$
4,033

 
0.93
%
 
$
429,928

 
$
5,050

 
1.17
%
 
$
453,680

 
$
7,365

 
1.62
%
Public time deposits
67,080

 
490

 
0.73

 
65,188

 
419

 
0.64

 
68,756

 
305

 
0.44

Savings deposits
123,179

 
49

 
0.04

 
110,936

 
98

 
0.09

 
97,686

 
160

 
0.16

Money market accounts
104,758

 
175

 
0.17

 
105,951

 
201

 
0.19

 
99,948

 
285

 
0.29

Interest-bearing demand
165,846

 
91

 
0.05

 
162,431

 
176

 
0.11

 
149,667

 
252

 
0.17

Short-term borrowings
1,807

 
7

 
0.39

 
942

 
1

 
0.11

 
763

 
2

 
0.20

FHLB advances
46,609

 
628

 
1.35

 
47,828

 
865

 
1.81

 
42,640

 
1,053

 
2.47

Trust preferred securities
16,322

 
683

 
4.18

 
16,315

 
699

 
4.28

 
16,321

 
686

 
4.20

Total Interest-Bearing Liabilities
$
960,372

 
$
6,156

 
0.64
%
 
$
939,519

 
$
7,509

 
0.80
%
 
$
929,461

 
$
10,108

 
1.09
%
Noninterest-bearing deposits
141,639

 
 
 
 
 
137,077

 
 
 
 
 
121,786

 
 
 
 
Other liabilities
4,505

 
 
 
 
 
3,984

 
 
 
 
 
4,605

 
 
 
 
Shareholders’ Equity
109,712

 
 
 
 
 
115,423

 
 
 
 
 
111,809

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
1,216,228

 
 
 
 
 
$
1,196,003

 
 
 
 
 
$
1,167,661

 
 
 
 
Net interest Income (FTE)
 
 
$
36,156

 
3.19
%
 
 
 
$
39,050

 
3.49
%
 
 
 
$
39,785

 
3.67
%
Taxable Equivalent Adjustment
 
 
(633
)
 
(0.05
)
 
 
 
(611
)
 
(0.05
)
 
 
 
(544
)
 
(0.05
)
Net Interest Income Per Financial Statements
 
 
$
35,523

 
 
 
 
 
$
38,439

 
 
 
 
 
$
39,241

 
 
Net Yield on Earning Assets
 
 
 
 
3.14
%
 
 
 
 
 
3.44
%
 
 
 
 
 
3.62
%
Note: Interest income on tax-exempt securities and loans has been adjusted to a fully-taxable equivalent basis. Nonaccrual loans have been included in the average balances.



21


Results of Operations (Dollars in thousands except per share data)
2013 versus 2012 Net Interest Income Comparison
Net interest income, the Corporation’s principal source of earnings, is the difference between interest income generated by earning assets (primarily loans and investment securities) and interest paid on interest-bearing funds (namely customer deposits and borrowings). Net interest income is affected by multiple factors including: market interest rates on both earning assets and interest-bearing liabilities; the level of earning assets being funded by interest-bearing liabilities; noninterest-bearing liabilities; the mix of funding between interest bearing liabilities, noninterest-bearing liabilities and equity and the growth in earning assets.
Net interest income for the year ended December 31, 2013 was $35,523 compared to $38,439 for the year ended 2012. Total interest income was $41,679 for 2013 compared to $45,948 for 2012, a decrease of $4,269. Total interest expense decreased $1,353 for the year-ended December 31, 2013, from $7,509 for 2012 to $6,156 for 2013. This resulted in a decrease in net interest income of $2,916 or 7.6% for 2013.
For purposes of the discussion below, net interest income is presented on a FTE basis to provide a comparison among all types of interest earning assets. Accordingly, interest on tax-free securities and tax-exempt loans has been restated as if such interest were taxed at the statutory Federal income tax rate of 34% adjusted for the non-deductible portion of interest expense incurred to acquire the tax-free assets. Net interest income presented on a FTE basis is a non-GAAP financial measure widely used by financial services corporations. The FTE adjustment for full year December 31, 2013 was $633 compared with $611 in 2012, which has been included as the Corporation considers it an important metric with which to analyze and evaluate the Corporation’s results of operations.
Table 2 summarizes net interest income and the net interest margin for the three years ended December 31, 2013.
Table 2: Net Interest Income
 
 
Year ended December 31,
 
2013
 
2012
 
2011
 
(Dollars in thousands)
Net interest income
$
35,523

 
$
38,439

 
$
39,241

Tax equivalent adjustments
633

 
611

 
544

Net interest income (FTE)
$
36,156

 
$
39,050

 
$
39,785

Net interest margin
3.14
%
 
3.44
%
 
3.62
%
Tax equivalent adjustments
0.05
%
 
0.05
%
 
0.05
%
Net interest margin (FTE)
3.19
%
 
3.49
%
 
3.67
%
The Corporation’s net interest income on a fully tax equivalent basis was $36,156 in 2013, compared to $39,050 in 2012. This follows a decrease of $735, or 1.8%, between 2012 and 2011. The net interest margin (FTE), which is determined by dividing tax equivalent net interest income by average earning assets, was 3.19% in 2013, a decrease of 30 basis points from 2012. This follows a decrease of 18 basis points for 2012 compared to 2011.
Interest income on a fully tax equivalent basis totaled $42,312 for 2013 compared to $46,559 in 2012, a decline of $4,247, or 9.1%. The decline in interest income was primarily a result of the continued lower interest rate environment and its impact on increased cash flow and reinvestment opportunities especially in the investment securities and indirect loan portfolios. Both portfolios have relatively short average lives and the lower interest rates have led to increased prepayments and lower reinvestment opportunities. Conversely, the shorter average lives would be expected to benefit the Corporation in a rising interest rate environment. Overall, average earning assets increased $15,027, or 1.3%, to $1,132,514 in 2013 as compared to $1,117,487 in 2012. Deposits generally have had a shorter average life and have repriced more quickly than loans, as evidenced by the decrease in interest expense which ended 2013 at $6,156 compared to $7,509 in 2012. The cost of funds dropped by 16 basis points from December 31, 2013 to December 31, 2012.

Average loans increased $19,634, or 2.2%, to $893,132 in 2013 as compared to $873,498 in 2012. The increase in average loans was mainly attributable to growth in the installment and commercial loan portfolios which increased $17,215 and $8,343, respectively. Offsetting these increases was a decline in the real estate mortgage portfolio of $5,611. Average home equity loans decreased $313, or 0.29%, from 2012. Investment securities, both taxable and tax-free, decreased $8,944, to


22


$217,882 in 2013 compared to $226,826 in 2012. Federal funds sold and other short-term investments increased $4,337 over the same period.
Average interest-bearing deposits increased by $21,200, or 2.4%, and average noninterest-bearing deposits increased $4,562, or 3.3%, during 2013, resulting in an increase in total average deposits of $25,762, or 2.5%, compared to 2012. The increase in average interest-bearing deposits was mainly a result of an increase in average savings deposit accounts of $12,243 or 11.0%. Average consumer time deposits, public time deposits, and interest bearing demand accounts increased year over year by 1.1%, 2.9%, and 2.1%, respectively. The Corporation uses FHLB advances as an alternative wholesale funding source. The use of FHLB advances as an alternative funding source remained relatively constant during 2013 in comparison to 2012. The Corporation may also use from time to time brokered time deposits as they are a comparably priced substitute for FHLB advances. Brokered deposits require no collateralization compared to FHLB advances which require collateral in the form of real estate mortgage loans and securities. At the end of 2013 and 2012, there were no outstanding brokered time deposits.
Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. Table 3 presents an analysis of increases and decreases in interest income and expense due to changes in volume (changes in the balance sheet) and rate (changes in interest rates) during the two years ended December 31, 2013. Changes that are not due solely to either a change in volume or a change in rate have been allocated proportionally to both changes due to volume and rate. The table is presented on a tax-equivalent basis.
Table 3: Rate/Volume Analysis of Net Interest Income (FTE)
 
 
Year Ended December 31,
 
Increase (Decrease) in Interest
Income/Expense in 2013 over 2012
 
Increase (Decrease) in Interest
Income/Expense in 2012 over 2011
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
 
(Dollars in thousands)
U.S. Govt agencies and corporations
$
(203
)
 
$
(700
)
 
$
(903
)
 
$
(224
)
 
$
(946
)
 
$
(1,170
)
State and political subdivisions
53

 
(4
)
 
49

 
325

 
(159
)
 
166

Federal funds sold and short-term investments
8

 
(15
)
 
(7
)
 
(31
)
 
9

 
(22
)
Restricted stock

 
(8
)
 
(8
)
 

 
8

 
8

Commercial loans
373

 
(1,894
)
 
(1,521
)
 
1,345

 
(1,861
)
 
(516
)
Residential real estate loans
(287
)
 
(123
)
 
(410
)
 
(234
)
 
(139
)
 
(373
)
Home equity lines of credit
(12
)
 
(155
)
 
(167
)
 
(43
)
 
68

 
25

Installment loans
558

 
(1,838
)
 
(1,280
)
 
937

 
(2,389
)
 
(1,452
)
Total Interest Income
490

 
(4,737
)
 
(4,247
)
 
2,075

 
(5,409
)
 
(3,334
)
Consumer time deposits
45

 
(1,062
)
 
(1,017
)
 
(279
)
 
(2,035
)
 
(2,314
)
Public time deposits
14

 
57

 
71

 
(23
)
 
137

 
114

Savings deposits
5

 
(54
)
 
(49
)
 
12

 
(74
)
 
(62
)
Money market accounts
(2
)
 
(24
)
 
(26
)
 
11

 
(95
)
 
(84
)
Interest-bearing demand
2

 
(87
)
 
(85
)
 
14

 
(91
)
 
(77
)
Short-term borrowings
3

 
3

 
6

 

 
(1
)
 
(1
)
FHLB advances
(16
)
 
(221
)
 
(237
)
 
94

 
(283
)
 
(189
)
Trust preferred securities

 
(16
)
 
(16
)
 

 
13

 
13

Total Interest Expense
51

 
(1,404
)
 
(1,353
)
 
(171
)
 
(2,429
)
 
(2,600
)
Net Interest Income (FTE)
$
439

 
$
(3,333
)
 
$
(2,894
)
 
$
2,246

 
$
(2,980
)
 
$
(734
)

Total interest income on a fully tax equivalent basis was $42,312 in 2013 as compared to $46,559 in 2012, a decrease of $4,247, or 9.1%. The decrease was attributable to an increase in volume of $490 and a decrease of $4,737 attributable to rate, when comparing 2013 to 2012. Of the $490 increase due to volume, installment and commercial loans increased by $558 and $373, respectively and were offset by a $287 decrease in residential real estate loans. Given the continued lower interest rate environment and the competitive nature of indirect lending, installment loans accounted for $1,838 of the decrease in interest income due to rate. Commercial loans by their structure are also sensitive to interest rates, accounting for $1,894 of the decline


23


in interest income due to rate. Total interest expense was $6,156 in 2013 compared to $7,509 in 2012. This is a decrease of $1,353, or 18.0%. Interest expense increased $51 attributable to volume and decreased $1,404 as a result of a decline in rates.
Total interest expense on a fully tax equivalent basis was $6,156 in 2013 as compared to $7,509 in 2012, a decrease of $1,353, or 18.0%. The decrease was attributable to an increase in volume of $51 and a decrease of $1,404 attributable to rate, when comparing 2013 to 2012. Of the $1,404 decrease due to rate, consumer time deposits decreased $1,062 year over year. This is a reflection of the low interest rate environment as the Corporation’s cost of funds decreased from 0.80% to 0.64% year over year.
Although difficult to isolate, changing customer preferences and competition impact the rate and volume factors. Due to the current lower interest rate environment, loans and investments continued to reprice at lower interest rates resulting in a decrease in net interest income due to rate of $3,333. The effect of changes in both rate and volume was a decrease of $2,894 in net interest income on a fully tax equivalent basis during 2013.
2012 versus 2011 Net Interest Income Comparison
Net interest income for the year ended December 31, 2012 was $38,439 compared to $39,241 for the year ended 2011. Total interest income was $45,948 for 2012 compared to $49,349 for 2011, a decrease of $3,401. Total interest expense decreased $2,599 for the year-ended December 31, 2012, from $10,108 for 2011 to $7,509 for 2012. This resulted in a decrease in net interest income of $802 or 2.0% for 2012.
Net interest income is presented on a FTE basis, to provide a comparison among all types of interest earning assets. Accordingly, interest on tax-free securities and tax-exempt loans has been restated as if such interest were taxed at the statutory Federal income tax rate of 34% adjusted for the non-deductible portion of interest expense incurred to acquire the tax-free assets. Net interest income presented on a FTE basis is a non-GAAP financial measure widely used by financial services corporations. The FTE adjustment for full year December 31, 2012 was $611 compared with $544 in 2011, which has been included as the Corporation considers it an important metric with which to analyze and evaluate the Corporation’s results of operations.
The Corporation’s net interest income on a fully tax equivalent basis was $39,050 in 2012, compared to $39,785 in 2011. This follows an increase of $673, or 1.7%, between 2011 and 2010. The net interest margin (FTE), which is determined by dividing tax equivalent net interest income by average earning assets, was 3.49% in 2012, a decrease of 18 basis points from 2011.
Interest income on a fully tax equivalent basis totaled $46,559 for 2012 compared to $49,893 in 2011, a decline of $3,334, or 6.7%. The decline in interest income was primarily a result of the continued lower interest rate environment and its impact on increased cash flow and reinvestment opportunities, especially in the investment securities and indirect loan portfolios. Both portfolios had relatively short average lives and the lower interest rates led to increased prepayments and lower reinvestment opportunities. Conversely the shorter average lives should benefit the Corporation in a rising interest rate environment. Overall, average earning assets increased $32,075, or 3.0%, to $1,117,487 in 2012 as compared to $1,085,412 in 2011. Deposits generally had a shorter average life and re-priced more quickly than loans, as evidenced by the decrease in interest expense which ended 2012 at $7,509 compared to $10,108 in 2011. The cost of funds dropped by 29 basis points from December 31, 2011 to December 31, 2012.
Average loans increased $45,321, or 5.5%, to $873,498 in 2012 as compared to $828,177 in 2011. The increase in average loans was mainly attributable to growth in the installment and commercial loan portfolios which increased $23,140 and $27,665, respectively. Offsetting these increases was a decline in the real estate mortgage portfolio of $4,392. Average home equity loans decreased $1,092 or 1.0% from 2011. Investment securities, both taxable and tax-free, decreased $3,094, to $226,826 in 2012 compared to $229,920 in 2011. Federal funds sold and other short-term investments decreased $10,152 over the same period.
Average interest-bearing deposits increased by $4,697, or 0.5%, and average non-interest-bearing deposits increased $15,291, or 12.6%, during 2012, resulting in an increase in total average deposits of $19,988, or 2.0%, compared to 2011. The increase in average interest-bearing deposits was mainly a result of an increase in average interest-bearing demand accounts of $12,764, or 8.5%, as well as increases of $6,003 and $13,250, or 6.0% and 13.6%, in average money market accounts and savings accounts, respectively. These increases were offset by decreases in public and consumer time deposit accounts of $3,568 and $23,752, respectively. The Corporation uses FHLB advances as an alternative wholesale funding source. The use of FHLB advances as an alternative funding source remained relatively constant during 2012 in comparison to 2011. The Corporation may also use from time to time brokered time deposits as they are a comparably priced substitute for FHLB advances. Brokered deposits require no collateralization compared to FHLB advances which require collateral in the form of real estate mortgage loans and securities. At the end of 2012 and 2011, there were no outstanding brokered time deposits.


24


Total interest income on a fully tax equivalent basis was $46,559 in 2012 as compared to $49,893 in 2011, a decrease of $3,334, or 6.7%. The decrease was attributable to an increase in volume of $2,075 and a decrease of $5,409 attributable to rate, when comparing 2012 to 2011. Of the $2,075 increase due to volume, loans accounted for $2,005 with both installment and commercial increasing $937 and $1,345, respectively. Given the continued lower interest rate environment and the competitive nature of indirect lending, installment loans accounted for $2,389 of the decrease in interest income due to rate. Commercial loans by their structure are also sensitive to interest rates, accounting for $1,861 of the decline in interest income due to rate. Total interest expense was $7,509 in 2012 compared to $10,108 in 2011. This is a decrease of $2,599, or 25.7%. Interest expense decreased $171 attributable to volume and $2,429 as a result of a decline in rates.
Changing customer preferences and competition impact the rate and volume factors. Due to the lower interest rate environment, loans and investments continued to reprice at lower interest rates, resulting in a decrease in net interest income due to rate of $2,980. The effect of changes in both rate and volume was a decrease of $734 in net interest income on a fully tax equivalent basis during 2012.
Noninterest Income
Table 4: Details of Noninterest Income
 
 
Year ended December 31,
 
2013
 
2012
 
2011
 
2013 versus
2012
 
2012 versus
2011
 
(Dollars in thousands)
Investment and trust services
$
1,555

 
$
1,563

 
$
1,610

 
(0.5
)%
 
(2.9
)%
Deposit service charges
3,509

 
3,811

 
4,079

 
(7.9
)%
 
(6.6
)%
Other service charges and fees
3,279

 
3,082

 
3,246

 
6.4
 %
 
(5.1
)%
Income from bank owned life insurance
752

 
742

 
722

 
1.3
 %
 
2.8
 %
Other income
521

 
877

 
330

 
(40.6
)%
 
165.8
 %
Total fees and other income
9,616

 
10,075

 
9,987

 
(4.6
)%
 
0.9
 %
Securities gains, net
178

 
189

 
832

 
(5.8
)%
 
(77.3
)%
Gain on sale of loans
2,324

 
1,575

 
889

 
47.6
 %
 
77.2
 %
Gain (Loss) on sale of other assets, net
8

 
(92
)
 
(293
)
 
(108.7
)%
 
(68.6
)%
Total noninterest income
$
12,126

 
$
11,747

 
$
11,415

 
3.2
 %
 
2.9
 %
2013 versus 2012 Noninterest Income Comparison
Amidst today's low interest rate environment, total noninterest income increased 3.2% for the year ended December 31, 2013 compared to 2012. Noninterest income was driven primarily from total fees and other income of $9,616, which was down 4.6% year over year, and the gain (loss) on the sale of assets which increased 50.1% year over year to $2,510.
Total fees and other income consists of five primary groups: investment and trust services, deposit service charges, other service charges and fees, income from bank owned life insurance and other income.
Investment and trust service income was $1,555, which was relatively consistent year over year, as commissions decreased slightly by 0.5%.
Deposit service charges decreased 7.9%, in 2013 to $3,509 from $3,811 in 2012. Service charges on deposit accounts are dependent on customer activity and behavior. Management reviews deposit account fee plans periodically to maintain consistency with competitors.
Total other service charges and fees, which consists of servicing fee income, bank card service charges and ATM service charges, increased by 6.4% in 2013 to $3,279 from $3,082 in 2012. The most prominent increase year over was in net servicing fee income which was $404 in 2013, compared to $272 in 2012, an increase of 48.5%. The Corporation retains the servicing rights for both sold mortgage loans and indirect auto loans.
Income from bank owned life insurance experienced a slight increase of 1.3%, to $752 during 2013 compared to $742 in 2012.


25


Other income, which includes mortgage banking activities, commercial SWAP fee income, safe deposit box fees and miscellaneous income decreased by 40.6% year over year to $521 in 2013 from $877 in 2012. Mortgage banking business declined in the second half of 2013, primarily due to higher interest rates and the fair value of the Corporation’s interest rate lock decreased substantially. Off-setting this decrease was $188 in commercial SWAP fee income recognized in 2013. No such income was recognized in 2012, as this product was not offered.
Gain (loss) on the sale of assets is comprised of the sale of securities, loans and other assets. Net gain on the sale of securities was $178 in 2013 compared to $189 in 2012. A gain of $8 was recognized on the sale of other assets during 2013 compared to a loss of $92 during 2012. The Corporation decreased the number of other real estate owned properties managed year over year.
The following table details the Corporations gain on the sale of loans for the years ended December 31:
 
Year ended December 31,
 
2013
 
2012
 
2011
 
2013 versus
2012
 
2012 versus
2011
 
(Dollars in thousands)
Gain on sale of mortgage loans
1,457

 
1,287

 
598

 
13.2
%
 
115.2
 %
Gain on sale of indirect auto loans
336

 
288

 
291

 
16.7
%
 
(1.0
)%
Gain on sale of SBA loans
531

 

 

 
100.0
%
 
 %
 
$
2,324

 
$
1,575

 
$
889

 
47.6
%
 
77.2
 %
The most notable increase in noninterest income was the gain on the sale of loans of $2,324 compared to $1,575 in 2012, an increase of 47.6%. The mortgage and refinance boom provided substantial gain over the past two years on the sale of mortgage loans, as the Corporation grew its mortgage operations. Gain on the sale of mortgage loans for 2013 was $1,457, an increase of 13.2% from $1,287 in 2012. This increase was recognized by the Corporation, despite a gradual decrease in loan sales due to the rising interest rate environment in the second half of 2013. The Corporation originates indirect auto loans in a niche market of high quality borrowers. A portion of these loans were booked to the Corporation’s portfolio and the remainder were sold to a number of other financial institutions with servicing retained by the Corporation. The gain on the sale of indirect auto loans was $336 for 2012, compared to $288 for 2012. During the fourth quarter of 2013, the Corporation established an SBA lending team, with the intent to originate to sell and generate revenue growth. For 2013, a gain on the sale of SBA loans of $531 was recognized.
2012 versus 2011 Noninterest Income Comparison
Total noninterest income was $11,747 in 2012 compared to $11,415 in 2011. This was an increase of $332, or 2.9%.
Total fees and other income, which consisted of noninterest income before gains and losses, was $10,075 in 2012 as compared to $9,987 in 2011. This was an increase of $88, or 0.9%. Deposit service charges, which included overdraft, stop payment and return item fees, amounted to $3,811 for 2012 as compared to $4,079 for 2011 and were negatively impacted by federal legislation limiting overdraft fees on debit card transactions. Other service charges and fees included debit, ATM and merchant services, which were $3,082 during 2012, a decrease of $164, or 5.1%, compared to 2011. Also included in other service charges and fees were servicing fees from sold loans. The Corporation retained the servicing rights for both sold mortgage loans and indirect auto loans. Net servicing fee income for 2012 was $272 compared to $298 for 2011.
Other income increased $547 to $877 in 2012 as compared to $330 in 2011. The increase was attributable to fees collected as part of the Corporation's decision to switch providers of its retail debit cards and from an increase in the fair value of interest rate lock commitments resulting from the strategy to grow its mortgage banking activities in 2012 and going forward.
The gains on the sale of mortgages for 2012 were $1,287 compared to $598 for 2011. This increase was due primarily to mortgage rates remaining near record lows during 2012, leading to strong refinance activity and an increase in local home buying in the Corporation's market. In the third quarter of 2012, the Corporation announced the opening of a Mortgage Banking Center in Solon, Ohio, as well as adding a sales team responsible for growing the mortgage business in Eastern Cuyahoga County. The gain on the sale of indirect auto loans was $288 for 2012, compared to $291 for 2011.
Due to the record low market interest rates during 2012, securities purchased at a premium were subject to faster prepayment rates, which reduced the yield on investments. To mitigate further margin pressure, the Corporation sold $25,462 of its available-for-sale securities prior to call or maturity in order to reinvest the proceeds in other securities before any further


26


interest rate cuts reduced the yield on securities available for purchase. Gains on the sale of available-for-sale securities were $189 in 2012 compared to $832 in 2011.
Noninterest Expense
Table 5: Details on Noninterest Expense
 
 
Year ended December 31,
 
2013
 
2012
 
2011
 
2013 versus
2012
 
2012 versus
2011
 
(Dollars in thousands)
Salaries and employee benefits
$
18,058

 
$
16,768

 
$
15,944

 
7.7
 %
 
5.2
 %
Furniture and equipment
4,234

 
4,782

 
3,987

 
(11.5
)%
 
19.9
 %
Net occupancy
2,310

 
2,207

 
2,310

 
4.7
 %
 
(4.5
)%
Professional fees
1,870

 
2,034

 
1,854

 
(8.1
)%
 
9.7
 %
Marketing and public relations
1,216

 
1,231

 
1,002

 
(1.2
)%
 
22.9
 %
Supplies, postage and freight
1,045

 
1,091

 
1,107

 
(4.2
)%
 
(1.4
)%
Telecommunications
669

 
731

 
727

 
(8.5
)%
 
0.6
 %
Ohio franchise tax
1,213

 
1,232

 
1,298

 
(1.5
)%
 
(5.1
)%
FDIC assessments
1,039

 
1,304

 
1,749

 
(20.3
)%
 
(25.4
)%
Other real estate owned
382

 
570

 
1,021

 
(33.0
)%
 
(44.2
)%
Loan and collection expense
1,427

 
1,150

 
1,364

 
24.1
 %
 
(15.7
)%
Other expense
1,724

 
1,803

 
1,781

 
(4.4
)%
 
1.2
 %
Total noninterest expense
$
35,187

 
$
34,903

 
$
34,144

 
0.8
 %
 
2.2
 %
2013 versus 2012 Noninterest Expense Comparison
Noninterest expense was $35,187 in 2013, compared to $34,903 in 2012, an increase of $284 or 0.8%. Expense management continued to be a major area of focus for the Corporation. Salaries and employee benefit costs represents the Corporation's largest noninterest expense, accounting for 51.3% of total noninterest expense, which is inherent in a service based industry such as financial services. Salaries and employee benefits increased $1,290 or 7.7%. During 2013, the Corporation recognized a $712 expense due to the establishment of the Supplemental Executive Retirement Plan, $153 in settlement charges due to the aggregate amount of lump sum distributions to participants in the Corporations defined benefit pension plan and increases associated with the launch of the Corporations newly formed SBA lending team. Other operating expenses were generally controlled as FDIC insurance costs decreased by $265, or 20.3%, and other real estate owned expenses decreased 33.0% which helped to offset the salary and employee benefits increase.
2012 versus 2011 Noninterest Expense Comparison
Noninterest expense was $34,903 in 2012, compared to $34,144 in 2011, an increase of $759 or 2.2%. Expense management continues to be a major area of focus for the Corporation. Salaries and employee benefit costs represented the Corporation's largest noninterest expense, accounting for 48.0% of total noninterest expense. Salaries and employee benefits increased $824 or 5.2%. The increase in salaries and employee benefits was part of the Corporation's strategy to increase revenues by expanding its market presence within northeast Ohio through the addition of experienced commercial and mortgage lenders and underwriters to support such growth. Professional fees increased $180, or 9.7%, compared to 2011, primarily as a result of legal expenses related to the Treasury’s auction of TARP preferred shares to private investors and costs associated with the conversion of the Corporation’s bank operating system.
While actions taken by the FDIC increased FDIC assessment costs in prior years, regulations which became effective in 2011 reduced the Corporation's FDIC insurance cost. FDIC assessments cost decreased $445 or 25.4%. Overall expenses related to the collection of delinquent loans and foreclosed properties decreased in 2012 compared to 2011. Other real estate owned expenses decreased $451 or 44.2% for 2012, mainly as a result of the lower number of properties transferred from the loan portfolio as a result of foreclosures. Loan and collection expense also decreased $214 or 15.7% in 2012, primarily due to lower problem assets under management in addition to overall improvements in credit quality.


27


Income Taxes
2013 versus 2012 Income taxes
The Corporation recognized tax expense of $1,926 during 2013 compared to $1,934 for 2012. The Corporation’s effective tax rate was 23.8% for 2013. Included in net income for 2013 was $2,044 of nontaxable income, including $624 related to life insurance policies and $1,420 of tax-exempt investment and loan interest income. The tax-exempt income, together with the Corporation’s relatively small amount of nondeductible expenses, led to income subject to tax that was significantly less than the Corporation’s income before income tax expense. The new market tax credit generated by North Coast Community Development Corporation (NCCDC), a wholly-owned subsidiary of the Bank, also had a significant impact on income tax expense and contributes to a lower effective tax rate for the Corporation. NCCDC’s new market tax credit award was granted on December 29, 2003 and will remain in effect through 2020. Over the remaining seven years of the award, it is expected that projects will be financed through NCCDC with the intent of improving the overall economic conditions in Lorain County and generating additional interest income through the funding of qualified loans for these projects and tax credits for the Corporation. The Corporation had total qualified investments in NCCDC of $9,000 at December 31, 2013 and December 31, 2012, generating a tax credit of $58 and $208, respectively.
2012 versus 2011 Income taxes
The Corporation recognized tax expense of $1,934 during 2012 compared to $1,156 for 2011. The Corporation’s effective tax rate was 24.1% for 2012. Included in net income for 2012 was $1,989 of nontaxable income, including $617 related to life insurance policies and $1,372 of tax-exempt investment and loan interest income. The tax-exempt income, together with the Corporation’s relatively small amount of nondeductible expenses, led to income subject to tax that was significantly less than the Corporation’s income before income tax expense. The new market tax credit generated by NCCDC, also had a significant impact on income tax expense and contributes to a lower effective tax rate for the Corporation. The Corporation had total qualified investments in NCCDC of $9,000 at December 31, 2012 and December 31, 2011, generating a tax credit of $208 and $270, respectively.

Financial Condition
Overview
The Corporation’s total assets at December 31, 2013 were $1,230,257 compared to $1,178,254 at December 31, 2012. This was an increase of $52,003, or 4.4%. Total securities available for sale increased $12,359, or 6.1%, over December 31, 2012. Portfolio loans increased by $19,751, or 2.2%, from December 31, 2012. Total deposits at December 31, 2013 were $1,045,589 compared to $999,592 at December 31, 2012. Total interest-bearing liabilities were $1,113,111 at December 31, 2013 compared to $1,063,453 at December 31, 2012.
Securities
The distribution of the Corporation’s securities portfolio at December 31, 2013 and December 31, 2012 is presented in Note 5 to the Consolidated Financial Statements contained within this Form 10-K. The Corporation continued to employ the securities portfolio to manage the Corporation’s interest rate risk and liquidity needs. At December 31, 2013, the entire portfolio consisted of available for sale securities comprised of 30.3% U.S. Government agencies, 43.6% U.S. agency mortgage backed securities, 8.6% U.S. collateralized mortgage obligations 15.3% municipal securities and 2.2% of preferred securities. This compares to 18.2% U.S. Government agencies, 54.8% U.S. agency mortgaged backed securities, 11.2% U.S. collateralized mortgage obligations and 15.8% municipal securities as of December 31, 2012.

The yield on an available for sale security depends on the purchase price in relation to the interest rate and the length of time the investor's principal remains outstanding. Mortgage-backed security yields are often quoted in relation to yields on treasury securities with maturities closest to the mortgage security's estimated average life. The estimated yield on a mortgage security reflects its estimated average life based on the assumed prepayment rates for the underlying mortgage loans. If actual prepayment rates are faster or slower than anticipated, the investor holding the mortgage security until maturity may realize a different yield.
At December 31, 2013, the available for sale securities portfolio had unrealized gains of $2,754 and unrealized losses of $8,651. The unrealized losses represent 3.9% of the total amortized cost of the Corporation’s available for sale securities. Available for sale securities with an unrealized loss position for twelve months or longer totaled $961 and available for sale securities with an unrealized loss position for less than twelve months totaled $7,690 at December 31, 2013. The unrealized gains and losses at December 31, 2012 were $5,330 and $338, respectively. See Note 5 to the Consolidated Financial Statements for further detail.


28


Tables 6 and 7 present the maturity distribution of securities and the weighted average yield for each maturity range for the year ended December 31, 2013.
Table 6: Maturity Distribution of Available for Sale Securities at Amortized Cost
 
 
From 1 to 5
Years
 
From 5 to 10
Years
 
After
10 Years
 
At December 31,
 
2013
 
2012
 
2011
 
(Dollars in thousands)
Securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
$
56,851

 
$
15,000

 
$

 
$
71,851

 
$
36,868

 
$
56,762

Mortgage backed securities
69,709

 
18,748

 
5,856

 
94,313

 
109,440

 
103,624

Collateralized mortgage obligations
14,012

 
3,700

 
938

 
18,650

 
22,483

 
29,537

State and political subdivisions
17,190

 
9,738

 
5,593

 
32,521

 
29,980

 
30,000

Preferred securities
4,684

 

 

 
4,684

 

 

Total securities available for sale
$
162,446

 
$
47,186

 
$
12,387

 
$
222,019

 
$
198,771

 
$
219,923

Although the above table indicates that a portion of the Corporation’s investment portfolio at December 31, 2013 matures after ten years, the actual average life and duration of the investment portfolio at December 31, 2013 was effectively much shorter due to imbedded call features of several U.S. government agencies as well as monthly cash flows received from U.S. mortgage-backed securities and U.S. collateralized mortgage obligations.

Table 7: The Weighted Average Yield for Each Range of Maturities of Securities
 
 
From 1 to 5
Years    
 
From 5 to 10
Years    
 
After
  10 Years  
 
At December 31,
 
2013
 
2012
 
2011
Securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies and corporations
1.92
%
 
0.02
%
 
%
 
1.87
%
 
1.30
%
 
2.07
%
Mortgage backed securities
2.50

 
2.27

 
2.43

 
2.45

 
2.75

 
3.76

Collateralized mortgage obligations
2.76

 
2.38

 
2.59

 
2.68

 
2.73

 
4.21

State and political subdivisions (1)
3.78

 
3.68

 
3.73

 
3.74

 
3.87

 
6.04

Preferred securities
4.97

 

 

 
4.97

 

 

Total securities available for sale
2.52
%
 
1.85
%
 
3.04
%
 
2.52
%
 
2.65
%
 
3.69
%
____________________________
(1)
Yields on tax-exempt obligations are computed on a tax equivalent basis based upon a 34% statutory Federal income tax rate.
Loans
The detail of loan balances are presented in Note 7 to the Consolidated Financial Statements contained within this Form 10-K.
Total portfolio loans at December 31, 2013 were $902,299. This was an increase of $19,751, or 2.2 %, over December 31, 2012. The Corporation believes that its loan portfolio was well-diversified at December 31, 2013. Commercial and commercial real estate loans represented 54.3%, indirect loans represented 22.9%, home equity loans comprised of 13.6%, residential real estate mortgage loans represented 7.4% and consumer loans comprised of 1.8% of total portfolio loans.
Loan balances and loan mix are presented by type for the five years ended December 31, 2013 in Table 8 below.


29


Table 8: Loan Portfolio Distribution
 
 
At December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
 
(Dollars in thousands)
Commercial real estate
$
401,591

 
$
414,005

 
$
381,852